Dovish MPC holds repo rate for durable recovery

RBI Governor Shaktikanta Das speaks on RBI monetary policy, Mumbai, on Thursday

10In a surprise move, the Monetary Policy Committee (MPC) persisted with its dovish stance, keeping policy rates unchanged in the backdrop of some loss of momentum in economic activity, the comfort provided by the improving inflation outlook, and the uncertainties related to Omicron and global spillovers.

The central bank gave a conservative real GDP growth projection of 7.8 per cent for FY23 against the Economic Survey’s projection of 8-8.5 per cent. CPI inflation for FY23 has been projected lower at 4.5 per cent(vis-a-vis FY22 forecast of 5.3 per cent) despite geopolitical tensions, elevated crude oil prices and persistent supply bottlenecks.

Inflation & outlook

Market experts were expecting a change in the policy stance given thatglobally central banks have turned hawkish,embarking on a tightening cycle, which could have implications for India in terms of capital outflows.

Explaining the rationale for the status quo, RBI Governor Shaktikanta Dassaid taking into consideration the outlook for inflation and growth, the MPC was of the view that continued policy support is warranted for a durable and broad-based recovery.

“We are living in a world ofKnightian uncertainty (which is lack of any quantifiable knowledge about some possible occurrence, as opposed to quantifiable risk)in the absence of determinate knowledge about the next mutation of Covid-19.

“The ability to forecast the future course of the economy is so contingent on the evolution of the virus that one prognosis is as good or as bad as the other and as ephemeral.”

The bond market gave the thumbs up to the monetary policy review with the bull-steepening of the yield curve on Thursday. Long-term bond yields are back towards pre-Budget levels. Intraday, price of the widely traded 6.10 per cent G-Sec maturing in 2031 jumped about 70 paise, with its yield declining sharply by about 10 basis points after Das read out his speech. Price of this paper closed 50 paise higher at ₹95.53 (previous close: ₹95.03). Its yield thawed about 7 basis points to close lower at 6.7480 per cent (previous close: 6.8227 per cent).

According to Aurodeep Nandi, India Economist and Vice-President atNomura, the RBI is likely to remain behind the curve, until macro circumstances warrant a shift of gears. “Sometimes markets expect dessert, but then realise that the main course is still not over. The RBI surprised by not only doubling down on its now familiar orthodoxy of keeping rates and stance unchanged, but also expressed a very dovish outlook for inflation for FY23.”

Das, however, refuted beingbehind the curve. “Global central banks are following a different path because of their various domestic factors... Our domestic factors are different,”he said.

Needlessly dovish

Arvind Chari, CIO, Quantum Advisors,said the RBI was being needlessly dovish. “The RBI should be preparing the markets on the change in policy. The backdrop has changed. We are no longer in crisis and hence do not need crisis time rates and monetary support.”

The six-member MPC voted unanimously to keep the policy repo rate unchanged at 4 per cent. The MPC decided by a majority of 5 to 1 to continue with the accommodative stance.The RBI, on its part, left the reverse repo rate unchanged at 3.35 per cent despite the rising short-term rates. Market players were expecting the reverse repo rate to be hiked by 20-25 basis points so that the policy corridor between the repo rate and reverse repo rate is narrowed in sync with the increase in short-term rates. This corridor was widened in three stages to 65 basis points in the March-May 2020 period amid the pandemic.

With the policy stance continuing to be accommodative, the RBI did not announce any measures to roll-back surplus liquidity from the banking system. Das observed that, overall, there is some loss of momentum of near-term growth while global factors are turning adverse. However, looking ahead, domestic growth drivers are gradually improving.

“The CPI inflation trajectory has moved in close alignment with our projections. In particular, the softening of food prices is providing welcome relief… The hardening of crude oil prices, however, presents a major upside risk to the inflation outlook,” Das said.

Core inflation (excluding highly volatile elements such as food and fuel) remains elevated at tolerance testing levels, although the continuing pass through of tax cuts relating to petrol and diesel last November would help to moderate input cost pressures to some extent, he added. On balance, headline inflation is expected to peak in Q4 within the tolerance band and then moderate closer to target in H2 (October 2022 to March 2023), providing room for monetary policy to remain accommodative, per MPC’s assessment.Going by the inflation assessment, the MPC may stand pat on rates for the better part of FY23, say experts.

Soumya Kanti Ghosh, Group Chief Economic Adviser, State Bank of India,said the RBI has indicated to the market that it is comfortable with making a clear distinction between policy strategy and policy stance and these can coexist simultaneously. “While a policy strategy may indicate RBI calibrating the liquidity normalization to ensure that government borrowings face no disruption, the policy stance may still indicate rate adjustment to quell inflation expectations, should inflation surprise on the upside beyond tolerance. These two mutually complement each other as RBI has several non-conventional policy tools to adjust Government borrowings,” Ghosh said. 

According to Ghosh, “While crude price increase may have bottomed out, the US yields might soften today on the back of lower-than-expected inflation print. The third and the largest elephant in the room is the size of the government borrowing programme. We expect for FY23, the government has budgeted a net market borrowing of ₹11.2-lakh crore, but that could be lower by at least ₹2.5-lakh crore.”

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